Crash Course on Incorporating Business for Tax Purposes Vs Sole Trader

• 

  AndyC1 on 10/04/2022 - 17:38

  +14

  You need to speak with a tax accountant. Ask your friends who they use and get some advice from them.

• 

  bemybubble on 10/04/2022 - 17:42

  +4

  Hey Op

  Be mindful of PSI rules. Your switch might be redundant…

  If you’re solely the service provider. I can see the results test tripping you up. Broadly speaking of course.

  Get professional advice. An accountant is a worthy investment for what you’re chasing

  • 

    oxleyroad on 10/04/2022 - 18:09

    Thanks for the comment. Yeah, a quick read seems to indicate I might be in a PSB exemption for my broad sole legal services. Would love to hear some expert opinion on that, local accountants here sometimes not that au fait with it.

    • 

      bemybubble on 10/04/2022 - 18:11

      Where are you located?

    • 

      Moderatorscrimshaw on 10/04/2022 - 18:16

      Your account is here

      https://www.ozbargain.com.au/user/107893

      Please continue discussion with your old account, thanks

    • 

      RMBC on 11/04/2022 - 10:34

      Your other issue is that as the sole shareholder, ultimately all income will go to you anyway. Bemybubble is correct, psi rules would almost certainly apply, based on the highly limited information provided

      Generally, of you earn the income, such as on providing legal professional services, the associated income sticks with you, and can also limit deductions

      Find an accountant you trust, I promise you that having a trusted financial advisor pays dividends; it's much easier, and cheaper, for us to help before the fact than to try and unwind things after

• 

  Quantumcat on 10/04/2022 - 17:44

  +10

  If you're earning $190k you can afford to engage an accountant

  • 

    oxleyroad on 10/04/2022 - 18:07

    -5

    Yes I can afford that, and I will at some point. I can also afford to post here :)

    • 

      jv on 10/04/2022 - 18:10

      +9

      I can also afford to post here

      Which is pointless and you cannot get financial advice here that are specific to your circumstances…

• 

  Adredocto on 10/04/2022 - 17:46

  You don't see the point in paying yourself super?

  • 

    AustriaBargain on 10/04/2022 - 17:56

    +1

    Surely if you have a successful business it makes more sense to invest money back into the business now rather than into super later.

    • 

      whitelie on 10/04/2022 - 18:04

      +1

      Wouldn't there be a better tax saving putting money in to super? Don't you pay like 15% tax on contributions up to $27.5k?

      • 

        AustriaBargain on 10/04/2022 - 18:25

        You pay no tax on the money you invest into your own business, including money spent paying or training employees.

        • 

          lubos on 10/04/2022 - 19:33

          +1

          @AustriaBargain: Yes. Then eventually your business goes belly up and you will have nothing to show for it.

          Always. Always. Always… max out your concessional super contribution if you can afford it. It's very tax effective. Only once you max out, invest the excess back into your business. If there is no excess to invest back into your business, then work harder.

          You've got to pay yourself first and start building some wealth as soon as possible. Never go all-in, putting all your income back into your business. If your business fails (fairly high chance), you might end up with nothing. It's happening to business owners in Australia all the time. Don't be one of them.

    • 

      oxleyroad on 10/04/2022 - 18:05

      -1

      Exactly. I think super is good, but I'm in my 30s and my values align with other uses for that money at the moment. That said, I don't understand all the tax intracacies, I welcome comment.

      • 

        jv on 10/04/2022 - 18:12

        +3

        Exactly. I think super is good, but I'm in my 30s and my values align with other uses for that money at the moment.

        You really need to speak to a good accountant before you make some big stuff ups that end up costing you a lot of money in the long term…

      • 

        bemybubble on 10/04/2022 - 18:20

        -1

        Op investigate a trust with a corporate trustee. Pay yourself a nominal wage so you don’t attract super or workcover.

        All assuming you satisfied the PSI rules…

• 

  MrHyde on 10/04/2022 - 18:15

  +3

  The key thing to keep in mind is that with a company structure - the money earnt stays in the company and is taxed at company rates. As soon as you pass that money to yourself for personal use - it will get taxed either as salary - (then you get taxed) or as dividends (with franking credits, etc, etc).

  If you are the only employee of the company; it really makes very little sense.

  • 

    mskeggs on 10/04/2022 - 18:23

    +3

    Can make a big difference if seeking to defer tax because you plan to take a year off or something that allows you to time when the income is received.
    Also consider future tax advantaged redundancy.
    A lawyer may also want to segregate assets for liability purposes.

    • 

      Gunther on 10/04/2022 - 18:27

      Or if you want to invest in your own company and make it grow…

      • 

        Almost Banned on 10/04/2022 - 19:49

        +1

        Or income split

• 

  camjl on 10/04/2022 - 22:44

  +6

  Hi oxleyroad,

  Plenty of good and bad advice in this chat.
  You will be earning PSI income, however, if you are working for the client and not contracting via an intermediary, you will most likely be a PSB regardless of your structure. I expect you would meet the results test, 80% rule / unrelated clients test, possibly not the business premises or employment tests (for now). Some form of advertising also shows that you are available to the general public and not tied to a (very) small client base. Probably try a little harder than just LinkedIn, Facebook and a cheap website.
  That said, if you intend to employ a family member / spouse, take an arms length approach when considering their remuneration.
  Look into STP, this is compulsory for all employees, including yourself, though if it is only you and/or 'closely held employees', you don't have to lodge as often, atm.
  Obviously your new entity will need its own ABN, TFN, GST and PAYGW registrations.
  Not sure where you are but in Qld, working directors / trustees are not covered by the standard workcover policy, nor is it compulsory for them. Here, you would need to enquiry about a policy to cover yourself, or look into some other income protection policy.
  From 1 July 2022, I believe super guarantee is going to be payable from dollar 1, the $450/mth threshold will disappear. If you really don't want to pay super, take the bare minimum wage to cover living costs or live off your savings, pay the tax in the company for yr1 then going forward, draw down (potentially fully franked) dividends from your retained earnings instead of taking future wages. That way you don't have to pay super on your dividends, you only pay the difference between your total tax (incl Medicare levy, maybe MLS, HELP etc etc) and the franking credit attached to the dividend.
  The company doesn't get a deduction for you taking dividends, but then you are personally only paying the top up tax, detailed below, or even getting a refund. The overall tax tends to even itself out over time, unless you can really ozbargain and defer taking those dividends until you drop back into a lower tax bracket at some point in the future. As someone else mentioned, the tax benefit is going to be insignificant if you are going to end up taking all of the company profits as wages and / or dividends.
  Be careful not to take more out of the company than you declare as a net wage and/or dividend, as you will create a debit director's loan (Div 7A) which you will need to deal with by either paying it back to the company plus interest as determined by the ATO, or take extra income, via journal entry (because, well you have already taken it in cash and or other benefits) and pay the extra tax and possibly super on it.
  If you buy a motor vehicle in the new entity, be aware of FBT. You will though, because the business entity has bought it, be able to claim the GST credits and immediate write off (before 30/06/2023?). Note though that when you sell or trade in that vehicle, the consideration received will be 100% taxable and GST will need to be remitted.
  The $300 depreciation limit won't apply to the company for phones, laptops, office furniture etc either.
  As someone else mentioned, a discretionary trust is a potential option. This way you can take either a wage or trust distribution - no super payable on trust distributions……
  Problem with the trust is that all net trust income has to be distributed to a beneficiary, otherwise it is taxed in the hands of the trustee at the top marginal rates (excl Medicare etc).
  You can use a 'bucket company', but that money typically has to be paid to the company…to do what? You would need a plan for it otherwise it will just in the bank account getting stuff all. If you want to invest this money, companies aren't always the best because they don't have access to the 50% general CGT discount after 12 months of asset ownership.
  Any money sitting in a company, whether it is a trading or a bucket company, is the company's money. Think of it as your actual employer - they won't give you extra money above your wages just because you want to buy a jet ski. If you what to get some out for yourself, you will typically have to pay 'top up tax', being the difference between your marginal tax rate et al and the franking rate (25% atm).
  Back to the discretionary trust, if you have other people that you can split the profits with, that can be very beneficial. And there isn't the same Div 7A loan problem, well you can get caught out if you have a bucket company and don't pay the money across. However, be aware of the ATO making noise about Sec 100A and the benefit of the distributions not going to the person paying the tax eg adult kids which I doubt you have at the moment! - ie a basic tax minimisation (avoidance if you ask the ATO) strategy. One that been used for decades but the ATO has their panties in a twist atm. A potential dulling of this ATO sword is in the wind though.
  If you are looking at a trust structure but are going to be the only individual beneficiary and not use a bucket company, I'm sure you are aware that you will need a corporate trustee - can't be the sole trustee and sole beneficiary.
  Not interested in super atm? At your age it may not be a priority, but an SMSF is a great investment vehicle for excess funds that you don't need for the next 30+ years. If you are thinking of additional investing, you can still get some LRBA funding for SMSF's. If you are just going to be rolling that money over from one investment to the next until you retire, it is going to be in a tax environment with a max tax rate of 15% and minimum of 0%, if you play by their rules. I have had / seen a few clients who have made literally $100,000's of tax exempt capital gains in their SMSF's after turning 60 and retiring. In one case it would have been $M's except the ATO brought in the TBAR cap crap a few years ago. I say crap mainly because it can be a PITA.
  If you need that money for yourself in the future, probably keep doing what you are doing for now….I'm not a financial advisor, so I'm only suggesting ideas and can't / won't recommend anything for you. There are traps around moving your super into an SMSF, such as insurance cover and the like, so you need to get advice on those things if you are interested in that.
  FYI basic income tax and Medicare on $100k in 2022 is about $24,200, so getting close to an avg rate equivalent to the 25% corporate tax rate.
  There are so many more things to discuss. Whatever you do has to be part of your overall long term strategy, so you should to speak with someone qualified & experienced if you want good advice.
  As always, DYOR and ignore all unsolicited advice, including this, I could have easily made a typo or explained something poorly or it gets misunderstood, or I just get something wrong.

  GL HF

  • 

    OzFrugie on 11/04/2022 - 01:53

    Nice write ups, lots of insights.

    I have few questions though.
    1. Which rule says that if you directly work with the end client ie not going through intermediary eg recruitment agency, it will be considered PSB?
    Is it also true regardless whether you meet the 80/20 rule or not?

    2. If going with discretionary trust and bucket company set up, for all the distributed money from trust to the bucket company, how can it be 'recycled' back to the trust so it can be invested under trust? Does it have to be a loan ie div7a?

    3. When the trading company sends the money to the discretionary trust, is it consider as gift or loan? Pros and cons?

    Thanks

    • 

      bemybubble on 11/04/2022 - 09:26

      Which rule says that if you directly work with the end client ie not going through intermediary eg recruitment agency, it will be considered PSB?
      Is it also true regardless whether you meet the 80/20 rule or not?

      This point speaks to the 'unrelated clients test'. Recruitment agency is considered as 1 client rather than multiple. More info can be found here

      If going with discretionary trust and bucket company set up, for all the distributed money from trust to the bucket company, how can it be 'recycled' back to the trust so it can be invested under trust? Does it have to be a loan ie div7a?

      If the trust keeps the money rather than paying the physical distribution to the company.

      When the trading company sends the money to the discretionary trust, is it consider as gift or loan? Pros and cons?

      Where a trust distributes to the bucket company and retains the funds - this creates a Div7a issue. Accountants do have strategies to mitigate this though.

      • 

        OzFrugie on 15/04/2022 - 00:41

        If the trust keeps the money rather than paying the physical distribution to the company.

        If no physical distribution from trust, then the income will be tax at highest marginal rate, no?
        Why would you want to do that? Isnt it better to distribute it to bucket company and get taxed 30% ?

        Where a trust distributes to the bucket company and retains the funds - this creates a Div7a issue
        Does the Div7a issue only occur when the money from the bucket goes to trust, or the moment you distribute from trust to bucket?

        • 

          bemybubble on 15/04/2022 - 01:06

          @OzFrugie:

          Why would you want to do that? Isnt it better to distribute it to bucket company and get taxed 30% ?

          A profit distribution doesn’t always translate to a cash distribution.

          If you were to practically pay the cash, you would open a bank account in the name of the bucket company but you wouldn’t be able to touch it without the same Div7a issues. Generally speaking of course

  • 

    [Deactivated] on 11/04/2022 - 20:33

    Really appreciate the info damjl. Some things to bring up with the accountant…

• 

  camjl on 10/04/2022 - 23:22

  Can't be arsed to read it all again. To confirm/correct, a bucket company will usually have to pay 30% tax, not the current 'base rate' of 25% as a trust distribution is considered passive income, not eligible small business income.

  • 

    sabracad on 11/04/2022 - 21:31

    +1

    You may want to revisit these rules.

    Your position seems to be based on the very early understanding of the BREPI definition and test. While I don't agree with it on principle, plenty of guidance was subsequently issued regarding income retaining its character when distributing directly from a trust conducting a business to a corporate beneficiary. Having said that, mixing in PSI/PSB considerations muddies things a little.

    • 

      camjl on 12/04/2022 - 19:42

      Hey, you may well be right. I'll claim that it was getting late and I had been waffling on in my comments for a good hour or so, adding & editing etc.
      In hind sight, I was probably thinking that the bucket company's own earnings are likely to be passive income because they tend to invest, not trade, even though they are not the ideal investment entity but you have to do something with the money once it's in there.
      Definitely the trust return does include an indicator for its income to be declared as BREPI and the nature of trust income tends to flow through with the distributions to the beneficiaries.
      I think then you have to consider the passive vs BREPI %'s to determine how the overall income has to be taxed.
      There you go, don't believe anything on the interweb.